Champions of Austerity Stick to their Guns

They came, they met, they conferred, they dashed from television studio to television studio. Whether all of this to-do at the meetings in Washington of the International Monetary Fund and the World Bank signified anything very much in the world outside of policymakers’ conference rooms is unclear. The IMF did get attention when it lowered its forecast of world growth this year from 3.5% to 3.3%, a testimonial to the faith of the fund’s economists in the precision of their forecasts.

These forecasters now think that the US, UK and China will grow more slowly than they anticipated only a few months ago; that the eurozone will have a more pronounced slowdown; and that Japan will awaken from a decades-long slumber as the new head of its central bank cranks up the printing presses to speeds that make the Federal Reserve Board’s Ben Bernanke look like a hard-money advocate.

More revisions will follow when the IMF rethinks its most recent rethink, a process familiar to other forecasters.

More important are the policy debates that bubbled up at the meetings and seminars held around Washington. Christine Lagarde, managing director of the IMF, applauded Japan for adopting a policy of quantitative easing twice the size of America’s, relative to the size of its economy “a welcome step” in support of world growth, she said.

That put the IMF on the side not only of Shinzo Abe, Japan’s prime minister, and the head of the Bank of Japan, Haruhiko Kuroda, but of Barack Obama, who sent his new treasury secretary, Jack Lew, to Europe to preach the need for expansionary monetary and fiscal policies to stimulate growth. Lew won no converts from faith in austerity.

Lagarde’s attack on proponents of austerity—which the IMF insists be practised in southern Europe—lines her up against German chancellor Angela Merkel and George Osborne, Britain’s chancellor of the exchequer, who believe that austerity is the route to sustainable economic growth in their countries. The disagreement between Lagarde and Merkel is not the first, and will not be the last dispute between French and German politicians over what is best for Europe.

The differences between proponents of austerity and of expansionary monetary policy are about the here and now, not the long run. Even those who favour loose monetary and fiscal policy hold these out as temporary measures: once the economies are growing again, budgets should be brought into balance, or nearly so, and central banks should sell off the assets they have taken onto their balance sheets, thereby reducing the money supply. It is the ability of politicians to give up the pleasure of spending money they do not have, and of central bankers to put quantitative easing into reverse—QE is a big vessel, not easily turned around—that austerity fans doubt.

Fortunately, this debate is not of great consequence outside the hallowed halls of the IMF. Osborne is not going to reverse course because Lagarde thinks he should, and Merkel is not going to unbalance the German budget and liberate Mario Draghi, the head of the European Central Bank, to join his Japanese, American and other central-bank counterparts as they toil over their printing presses simply because Lagarde thinks Draghi should. Countries that need IMF help in procuring bailouts might treat the IMF’s views with deference, but other nations will not.

This might not be a bad thing. Every nation has different political, cultural and economic needs: as with the euro, one size does not fit all.

Japan, the victim of decades of stagnation as consumers and businesses postponed spending because deflation would make things cheaper tomorrow, and all the tomorrows after that, needs to break deflationary expectations by flooding the country with cash to create expectations of inflation. Buy now or pay more later might persuade consumers to spend some of the $8.8 trillion they have put away in anticipation of lower prices.

Germany has an entirely different problem. Its history makes its voters dubious of the advantages of a Japanese-style inflationary policy. Besides, Merkel presides over a eurozone desperately in need of reforming its labour markets, its education systems, and its banking sector, among other things. An infusion of easy cash would enable reluctant politicians to postpone these reforms by burying their structural problems under a pile of paper money.

In Britain, Osborne has still a different problem moving the boundary line between the state and private sectors to bring the welfare state down to a size the country can afford. Austerity is a welcome by-product of that effort.

To the irrelevance of general policy preachments to the circumstances of individual countries, add the uncertain empirical underpinnings of such preachments. Like many others, including top American policymakers, I have relied on a study by Harvard University’s Kenneth Rogoff and Carmen Reinhart for the proposition that when public debt exceeds 90% of GDP, growth turns negative. But researchers at the University of Massachusetts now find that such a debt burden is associated with positive growth of 2.2%. Rogoff and Reinhart, they say, committed “coding errors,” selectively excluded “available data,” and made other “serious errors that inaccurately represent the relationship between public debt and GDP growth.”

So when next the IMF or any organisation offers an over-arching, empirically based policy solution to the world’s ills, do reach for a pinch of salt.